This article was originally published 19 December 2012
Does your defined benefit (DB) plan provide actuarial increases to participants who work beyond normal retirement age? It's a nice gesture, but you may be in for a shock. Many people in recent years have chosen to delay their retirements because of the poor economy or simply because people are living longer, and it doesn’t take long for an actuarial increase to make a modest pension benefit look like a lottery jackpot.
DB plans are required to provide an actuarial increase on the normal retirement benefit unless the participant receives a Suspension of Benefits notice shortly before their normal retirement date, saying that their pension payments will be suspended as long as they continue working. Furthermore, even if suspension notices are provided, plans must provide an actuarial increase to benefits beyond age 70½ (even if the plan has changed its Required Minimum Distribution age to 72).
What's an actuarial increase?
An actuarial increase is sort of the opposite of an early retirement factor, which reduces the benefit to compensate for it being paid over a longer timeframe. An actuarial increase compensates for the benefit being paid over a shorter timeframe. For example, a $500 monthly pension starting at age 65 would be equivalent to a larger benefit starting at a later age:
| Starting age | Increased benefit |
|---|---|
| 66 | $562 |
| 67 | $633 |
| 68 | $716 |
| 69 | $812 |
| 70 | $925 |
| 71 | $1,058 |
| 72 | $1,216 |
| 73 | $1,403 |
| 74 | $1,628 |
| 75 | $1,898 |
| 76 | $2,227 |
| 77 | $2,629 |
| 78 | $3,125 |
| 79 | $3,742 |
| 80 | $4,514 |
As you can see, it doesn’t take long for a participant's benefit to double or even triple and that's even true for frozen DB plans!
What about the 415 limit?
The 415 limit is the IRS-imposed limit on someone’s annual pension benefit. It almost never applies anymore. But actuarial increases can get people into 415 territory. Here’s how…
When most plan administrators think of the 415 limit, they think of the maximum dollar amount (currently $245,000) for DB plan benefits under Internal Revenue Code section 415(b). This dollar limit rarely applies because the compensation limit (currently $305,000) usually prevents pensions from getting that high, and the dollar limit is increased for later ages. However, section 415(b) also limits a participant's pension to 100% of average compensation, which is not increased for later ages. If actuarial increases are driving participants’ benefits upward, the 100% of pay limit could come into play, especially for long-service participants. Unfortunately, this pay limit disproportionately affects lower-income people.
Plan rules may vary
All DB plans are different. Some provide actuarial increases and some don’t. The ones that do may use different interest rates and mortality tables, which would raise or lower the amount of the increase. These rules are specified in the legal plan document. It’s important to know how your pension plan works.